Outsourcing Matures, Slowly

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In 2007, when European investment firm Skandia began a multiyear push to move away from its paper-based processes and tap the full powers of the Internet, it encountered a problem: the massive project had huge implications for the company’s overall IT infrastructure, including the need to develop a sophisticated data warehouse. But Skandia was locked in to a $175 million outsourcing arrangement with Indian outsourcing-services vendor HCL Technologies that had a number of years yet to run.

Under the terms of the service-level agreement (SLA), HCL had been hired to develop applications and manage the infrastructure of Skandia’s old legacy systems, along with absorbing 250 of Skandia’s IT employees — nothing more, nothing less. At the time it was drawn up, the SLA “was smart,” says Mark Satchel, a 10-year Skandia veteran who was appointed CFO in 2009. “But it later resulted in a great deal of inflexibility.”

Or appeared to. But rather than parting company, Skandia and HCL agreed to craft a new agreement, running to 2012. According to Satchel, Skandia now has much more flexibility to use outsourcing according to the “peaks and troughs” of its needs, while tapping into a range of HCL consulting services that weren’t available under the initial contract.

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Although the agreement was rescued successfully, Satchel is circumspect. As he notes, the firm’s various outsourcing arrangements — of which HCL is “by far the largest” — are “under constant review as Skandia looks to do more.” And he sounds a cautionary note for his fellow CFOs, warning them to be cognizant of the resources needed to make outsourcing work. “We spend a lot of time analyzing and documenting what both we and the outsourcers need to do.” Despite all that effort, he adds, “there are times when I wonder whether what you gain on one side you lose on the other.”

While doubts may linger, there is no denying that the pressure is on for CFOs to push outsourcing engagements further, particularly now that most have achieved the cost savings they had targeted. “Just because you’ve saved 20% or 30% by outsourcing, say, aspects of finance and accounting [F&A] doesn’t mean your boss won’t turn around in two years and ask, ‘What have you done for me lately? Where is my next 20% coming from?'” says Phil Fersht, CEO of HfS Research, an outsourcing advisory firm.

“Companies that have already outsourced are continuing to outsource more, not less,” Fersht adds. He cites an HfS poll from 2010 that found that, of 209 firms currently outsourcing some facet of finance, 40% planned to expand the number of F&A processes they outsourced, while fewer than 10% expressed interest in pulling back in-house what they had outsourced.

HfS also reports that between 2004 and 2010, companies entered into 788 engagements that bundled two or more core F&A processes, including an estimated 109 last year alone, compared with 51 in 2004.

But amid that growth, some findings merit attention, notably the fact that average contract values have been shrinking — to an estimated $18.3 million in 2010 from $30.4 million in 2004.

Fersht suggests that as the average deal for business-process-outsourcing arrangements declines in value, newer providers may be only too happy to take on smaller, less-profitable contracts, hoping they can expand them. And that could give companies more vendors from which to choose, and more opportunity to play one against another.

Making It Work

Companies would love to see more competition drive down prices, of course, but that alone won’t make outsourcing decisions all that much simpler. Often the more important starting point is to think carefully about what is being outsourced, and how. “We have seen cases with F&A outsourcing of companies that moved too many processes at once over to a third party, and those processes had to be pulled back because they just went out too soon,” says David Upton, professor of operations management at Oxford University’s Saïd Business School. Two common errors: failing to take the time up front to do a detailed analysis of a process being outsourced, and not preparing staff for what needs to change internally to help the outsourcing agreement run smoothly.

Even before addressing those kinds of execution challenges, companies need to think about whether a given process should be outsourced at all. Often that hinges on determining whether or not it is “core,” an issue far more difficult than it may appear.

As Upton notes, particular processes are often outsourced as a way to achieve quick cost-saving goals, without the company understanding that those processes either are or might become a core competency that differentiates a company from its rivals. “People say, ‘It’s not really our core competence, so someone else should do it.’ But by saying that, they’ve made sure that it never will be,” says Upton. “What may appear to be a short-term financial decision often ends up being a longer-term strategic one.” He advises companies to focus on what they will become, versus what they are today, and to remember that current noncore competencies may become a source of innovation.

Understanding what a company’s core competencies may or may not be stymies many executives, agrees Stuart Drew, senior vice president of financial services in Europe at HCL Technologies. “Companies do need to ask, ‘What is our core business?’ And that’s what should be kept in-house,” he says. “But it is a huge challenge. One board will say 85% of what we do is core, another will say 15% is, and both will be right.”

Assuming a company has worked out those issues, and has crafted an agreement that builds in plenty of flexibility, another key will be to avoid the temptation to then forget about the process altogether. Tony Chambliss, managing director of business-process-outsourcing services at Accenture, says that continually modifying an outsourcing engagement is now standard operating procedure as outsourcing agreements evolve into true partnerships.

Outsourcing engagements can’t stand still. As CFOs gain a better understanding of what their companies can and can’t outsource, “there is a big debate about what the role of outsourcers should be — are they being hired to help run the business, or change the business?” says Drew. The answer could be both.

Janet Kersnar is a London-based journalist.

What’s Ahead?

As the economy recovers, HfS Research predicts that two segments of the business-process-outsourcing (BPO) market will see a marked increase in deals in 2011: finance and accounting (F&A) and procurement. Nearly a quarter of midmarket companies (defined as those with annual revenue of $1 billion to $3 billion) will take their first steps toward F&A outsourcing this year, according to HfS. And they may find some good deals. Many service providers in this space, HfS says, will adopt a “penetrate and radiate” strategy, luring companies with small contracts that include scant profit margin, in the hopes that happy customers will sign on for additional, higher-margin deals over time. The research firm also predicts that service providers will expand beyond their current siloed structure, offering more forms of outsourcing across a broader swath of industries. There will also be a blurring of IT and BPO services as vendors in each space try to become more cost-effective by appealing to potential clients outside their current bases. — J.K.